The tax system must include stimuli to be smart, hard working, and healthy

Andres Võrk, analyst of labour and social policy of the Centre for Policy Studies Praxis and Lecturer of Econometrics at the University of Tartu finds there is no single, definite tax system. Besides, the primary issue is not simply taxes, but easily administered taxes.
A common public speech on taxation creates the picture of a war movie where generals stand at a big frame moving boxes on it with a long blade – that tax must be increased, that one decreased, that transferred to the employees. What is your attitude to the Estonian tax system?
Firstly, we should start with a question about why we need a tax system in the first place. What are its objectives? There are four of them.

The most important one of course is to bring money into the public sector budget in order to provide services for the people. In order to fulfil that objective, we must see what kind of taxes ensure income, while at the same time causing as few distortions in the economy as possible.
The second objective is to consciously change the behaviour of people or companies if they would otherwise harm themselves or others. For that purpose, goods are made more expensive with taxes to decrease their consumption. An example would be tobacco excise duty, or a tax on plastic bags.
Thirdly, taxes together with social benefits have a function of reallocation of incomes. The desired scope of reallocation depends largely on the values of the society.
And fourthly, the tax system should contribute to macroeconomic stability. Namely, some taxes, such as a progressive income tax, help to smoothen the big ups and downs of economic cycles.
Surely it cannot be said there is a certain definite tax system, the best for all countries. In Estonia, two extremes have remained. On the one hand, a dogmatic position that you must not meddle with taxes. But if the objectives of society and the economic and social environment around us change, taxes must also change. On the other hand, however, you really should not meddle with taxes without a particular reason – these should not be changed without thorough analysis.

What is the Estonian tax system characterised by? Who would bear the final cost?
When looking at general trends in taxation policy, the objective is to impose fewer taxes on making profit and more on consumption. In the past few years, VAT and excise duties have been raised. At the same time, however, the decrease in labour taxes has decelerated. In the conditions of economic crisis, it was not possible to continue decreasing them and, instead, they increased.
If we look at international comparisons, the actual tax burden of companies in Estonia is one of the lowest. Business income will only be levied after it is taken out of the company. As a result of it, the majority of business income is not taken out, or it is taken out tax-free abroad. Consumption is taxed here more than the European average, and the labour tax burden is at an average level. The general tax burden remains slightly below the European average.

Alright, slightly lower than the European average. Is it too low then, still too high, or suitable?
Taxes whether high or low are not the ultimate goal. Neither is the last or first place of interstate tax burden the ultimate goal. Taxes are just a means to fulfil society’s wishes. It is important that for the income from tax the public sector would do things that people want the most, and they would be certain that these would be better achieved collectively than when going it alone.

Tax has actually several faces, too. One is the simple one, for example the value added tax. The other is a tax for what we receive a certain service. For example, unemployment insurance premium – for that we get unemployment insurance. Actually, the dividends of public undertakings are also taxes. For example, the dividends of Eesti Energia go to the state – consumers pay for these through a higher electricity price. Also state fees that are considerably higher than the service provision cost could be considered taxes.

So taxes are not as simple as they claim?
The simplicity of a tax system cannot be a separate goal. A common tax for everyone may not necessarily fulfil all of the objectives of a tax system. Tax system administration is what must be simple to avoid abundant costs when collecting taxes.
The tax system must include stimuli to be smart, hardworking, and healthy as well as favouring entrepreneurship. The problem with the current Estonian tax exemptions is rather the fact that they lack clear objectives or the selected measures are not the most reasonable ones for achieving those objectives. An example of this is the tax incentive of the housing loan, which is not approved of by any economy experts.
Instead, several Estonian tax experts recommend using tax incentives in a courageous way for stimulating the companies’ research and development or increasing the education level of the employees. If necessary, even reinstating the taxation of traditional profit for companies, but at a lower tax rate than before.
Even a complicated weighted system with exceptions must still be simple in the administrative sense. And definitely the contrary effect should not occur where a seemingly simple tax – such as the local sales tax – appears administratively complicated.

Is it feasible to impose new taxes in Estonia?
The trend should not be towards imposing taxes on making profit, but on the wealth, whether it is cars or real estate.
In connection with elections, the tax issue will probably be raised again; it already has been. But a more serious discussion requires more analyses than there are today. Do not be deceived by the tax slogans of marketing experts and media advisers and ask more bravely for substantial and numerical analyses.

How do you feel about imposing a ceiling on social tax?
That is principally a thing that should be carefully considered. If it were set it too high, it would not really affect anything. If it were set it too low, however, it would be bad for the budget of the social field.

Many people demand a general decrease in labour taxes. What do you think of that?
It raises the question of how obligations of the public sector would be financed. I do not consider it very realistic that in the long-term taxes, including labour taxes, would fall. EU support and the sums received from the sale of carbon dioxide emission quota constitute quite a big share of the income of the Estonian state budget right now. It is hard to say exactly but I think that they will not increase in the next few years, but rather they will decrease. But if the costs of the public sector remained at the same level, it would be difficult to say where else that money should come if not from taxes.

Our business tax system that was mentioned above has been mentioned as a huge Estonian idea. How would you assess its impact?
As the division of profit, and not the making of it, is taxed in Estonia, i.e. tax is gathered from business profit at the moment of dividing the profit, it should principally increase investments, whereas the state loses tax revenues for a short time. Does the increase of productivity coming from investments outweigh those missed tax revenues? At the end of the year, a large study on that particular subject will be completed by the University of Tartu and Praxis. Initial calculations have shown that productivity has indeed increased and tax revenues have decreased from profit at the same time. The question remains whether the state would have handled the tax money better than business.

But another domestic policy idol, gradual income tax?
Gradual income tax helps achieve a tax system goal – the reallocation of revenues. So it is a matter of values. In an economic sense, one should consider how much the gradual income tax drags business and people’s motivation to work and whether the impact on the reallocation of revenues outweighs it. But the ultimate answer to these questions probably depends on the values and political views of the respondent.